Question

(Change in Estimate) Mike Crane is an audit senior of a large public accounting firm who has just been assigned to the Frost Corporation’s annual audit engagement. Frost has been a client of Crane’s firm for many years. Frost is a fastgrowing business in the commercial construction industry. In reviewing the fixed asset ledger, Crane discovered a series of unusual accounting changes, in which the useful lives of assets, depreciated using the straight-line method, were substantially lowered near the midpoint of the original estimate. For example, the useful life of one dump truck was changed from 10 to 6 years during its fifth year of service. Upon further investigation, Mike was told by Kevin James, Frost’s accounting manager, “I don’t really see your problem. After all, it’s perfectly legal to change an accounting estimate. Besides, our CEO likes to see big earnings!”

Instructions Answer the following questions.

(a) What are the ethical issues concerning Frost’s practice of changing the useful lives of fixed assets?

(b) Who could be harmed by Frost’s unusual accounting changes?

(c) What should Crane do in this situation?

Short answer

There will be no ethical issue if there is a reason to change the useful life of the asset. It will affect future period calculations and Crane should report this upper management of the company.

Step-by-step solution

Ethical issues

There are no ethical issues in changing the useful life of any fixed asset of the business. Under both GAAP and IFRS, changes in methods of depreciation and any change in estimated useful life are reported in current and future periods.

Unusual accounting changes will cause harm

In this case, any significant change made to the asset will affect its useful life. This will not affect prior period depreciation but it will affect future periods.

Actions of Crane

Crane should report these changes to the upper management of the company, also this needs to be disclosed in a form of a report containing all the findings.